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Appendix - Chapter 8.2 – Stand-Alone Open-Air Parking Structures

Introduction

The IRS and the taxpayer agree that stand-alone open-air parking structures are inherently permanent. Accordingly, the issue is whether these parking structures are buildings or land improvements for depreciation purposes. Taxpayer asserts that the parking structures are land improvements with a 15-year recovery period and 150% declining balance method of depreciation (under GDS) while the IRS asserts that the parking structures are buildings with a 39-year recovery period and straight-line method of depreciation (under GDS).

Open-air parking structures have been constructed since the mid-1950s. Stand-alone open-air parking structures typically provide multi-level parking accessed by a ramp system. These parking structures have at least two sides that are approximately 50 percent open to the outside because they were designed to eliminate the need for heating and ventilation systems. Aside from those vehicles parked on the top level, the vehicles are protected from sun, rain and snow. Moreover, drivers and passengers are protected from these elements as well as from ice and to some degree, wind. In almost all parking structures, the top, exposed level has the fewest vehicles.

The parking structures are normally constructed of concrete and supported by steel-reinforced concrete pillars. The garages have foundations, concrete decks, steel-reinforced concrete support pillars, partial walls, concrete ramps connecting each floor, concrete wheel stops, bollards, and guardrails. Some have underground parking levels, which have full walls. The parking structures typically have hydraulic elevators and internal stairwells (every parking structure is required by the Uniform Building Code to have a minimum of two means of egress (stairs) which are separated from each other). The elevator mechanical systems (hydraulics and motors) are housed in an equipment room located adjacent to the elevators.

The parking structures also have interior lighting (pole-mounted lighting on the top level), security cameras, fire sprinklers (depending on the height and area of the structure), and signage to facilitate safe and speedy evacuations during an emergency. While fires in parking structures are generally more related to the vehicles parked within them than to the typical structural materials, the fire system (if required by code provisions) is usually comprised of the fire alarm wiring, pull stations, strobes, annunciators, and exit signage. Many parking structures have a separate area or room for electric metering and switching.

§ 168 set forth the MACRS depreciation system. MACRS generally applies to tangible property placed in service after December 31, 1986. § 168(a) provides that the depreciation deduction provided by § 167(a) for any tangible property is determined by using the applicable depreciation method, recovery period, and convention. Under MACRS, the recovery period of property is determined by reference to its class life or by statute.

Nonresidential real property is § 1250 property that is not (1) residential rental property or (2) property with a class life of less than 27.5 years. § 168(e)(2)(B). § 1250 property is any real property (other than § 1245 property, as defined in § 1245(a)(3)) which is or has been property of a character subject to the allowance for depreciation provided in § 167. §§ 168(i)(12) and 1250(c). The cost of nonresidential real property placed in service after May 12, 1993, is generally recovered over 39 years.

Taxpayers argue that stand-alone open-air parking structures are land improvements, with a recovery period generally of 15 years. Land improvements are defined in Rev. Proc. 87-56, 1987 2 C.B. 687 (Asset Class 00.3), which states, “Includes improvements directly to or added to land, whether such improvements are § 1245 property or § 1250 property, provided such improvements are depreciable. Examples of such assets include sidewalks, roads, canals, waterways, drainage facilities, sewers (not including municipal sewers in Class 51), wharves and docks, bridges, fences, landscaping, shrubbery, or radio and television transmitting towers. Does not include land improvements that are explicitly included in any other class, and buildings and structural components as defined in § 1.48-1(e) of the regulations....”

Therefore, if these parking structures are buildings, they are not land improvements.

The determination of whether a structure constitutes a building is based on the definition of a building in Treas. Reg. § 1.48-1(e)(1). The regulation provides, “The term ‘building’ generally means any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The term includes, for example, structures such as apartment houses, factory and office buildings, warehouses, barns, garages, railway or bus stations, and stores. …” [emphasis added]

In Yellow Freight System, Inc. v. Commissioner, 538 F.2d 790, 795-796 (8th Cir. 1976), the court noted, “This regulation conforms to the congressional understanding of the term “building,” see The Technical Explanation of the Bill, U.S. Code Cong. & Admin. News pp. 3439, 3456 (1962), and follows Congress' intent that the term “building” be given its commonly accepted meaning.” Thus, for depreciation purposes, the term “building” is given its commonly accepted meaning.

The regulation has been interpreted by various courts to include an appearance test and a function test. The first part of the definition (“any structure or edifice enclosing a space within its walls, and usually covered by a roof”) is known as the appearance test. The second part of the definition (“the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space”) is known as the function test.

Taxpayers and the Service disagree on whether a stand-alone, open-air parking structure satisfies this two-part definition of a “building” under Treas. Reg. § 1.48-1(e)(1).

Taxpayers contend that the parking structures, if not connected to an actual building, are land improvements with a 15-year recovery period. However, Taxpayers agree that parking structures connected to a building have a 39-year recovery period.

Taxpayers argue that stand-alone, open-air parking structures do not meet the definition of a building because they fail the appearance test. Specifically, taxpayers argue that a stand-alone, open-air parking structures fail the appearance test because they: 1) do not contain walls or a roof for the specific purpose of sheltering people or vehicles; 2) are open to the elements (weather); and 3) do not have many of the structural components of a building and/or do not share structural supporting elements with a building.

Taxpayers further argue that stand-alone, open-air parking structures do not meet the definition of a building because they fail the function test. They argue that courts analyze the function test by determining whether the structure provides more-than-incidental shelter or working space for humans or machinery, which is more than merely incidental to the principal function of the structure. Taxpayers assert that the structures do not provide shelter for significant machinery and the limited human activity in the structures is incidental to the garage’s principal function of temporary vehicle storage. Furthermore, for functional purposes, taxpayers analogize the structures to paved surface parking lots that happen to be stacked one atop the other.

The Service’s position is that stand-alone, open-air parking structures constitute buildings with a 39-year recovery period.

The Service argues that stand-alone, open-air parking structures fall within the definition of a “building” because they satisfy the appearance test. Treas. Reg. § 1.48-1(e)(1) states that the term “building” generally means a structure enclosing a space within its walls, and usually covered by a roof. The regulation section does not require a structure to have walls or a roof in order to be classified as a building. However, the Service asserts that a stand-alone, open-air parking structure does enclose a space within its walls. Even though the structures’ exterior walls do not extend from floor to ceiling, the partial, exterior walls separate the structure from the surrounding area and enclose vehicles within it. Moreover, stand-alone open-air parking structures possess structural components that are naturally associated with a “building.”

The Service further argues that stand-alone, open-air parking structures fall within the definition of a building because they satisfy the function test. Treas. Reg. § 1.48-1(e)(1) provides that a structure constitutes a building if the purpose of the structure is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The regulation section does not require a structure to meet all possible building functions in order to satisfy the function test. In the current case, the parking structures at issue clearly provide parking space, which is one of the functions specifically enumerated in Treas. Reg. § 1.48-1(e)(1). Furthermore, the structures shelter the parked vehicles from sun and precipitation.

Treas. Reg. § 1.48-1(e) is clear and unambiguous in providing that the term “building” includes structures such as garages, and structures the purpose of which is to provide parking space. Since garages and parking structures are explicitly included in the definition of a building under Treas. Reg. § 1.48-1(e), this should really be the end of the inquiry as to whether a parking structure is considered a building.

Although it is clear and unambiguous that garages and parking structures constitute buildings under Treas. Reg. § 1.48-1(e), taxpayers attempt to introduce ambiguity into the definition of a building with regard to parking structures. For the sake of argument, this rebuttal will address the arguments raised by the taxpayer.

Function Test

The function test under Treas. Reg. § 48-1(e)(1) requires the structure or edifice to provide shelter or housing, or to provide working, office, parking, display, or sales space. The stand-alone open-air parking structures clearly provide parking space. Taxpayers may argue that the parking structures fail the function test because they do not provide workspace or shelter. However, Treas. Reg. § 1.48-1(e)(1) does not require a structure to meet all of the possible building functions and does clearly state that providing a parking space is a building function. Further, open-air parking structures do provide shelter for the vehicles from sun and precipitation, especially those located in the interior portion of the structure. They similarly provide shelter for drivers and passengers when entering and exiting the vehicles.

Appearance Test

The appearance test under Treas. Reg. § 1.48-1(e)(1) requires a structure or edifice enclosing a space within its walls, and usually covered by a roof. A stand-alone open-air parking structure clearly encloses a space within its walls. The walls of a parking structure separate the parking structure from the surrounding area and enclose vehicles within the structure. While it is not mandatory that a structure have a roof under Treas. Reg. § 1.48-1(e)(1), the top level of a stand-alone open-air parking structure is simply a useable roof.

Taxpayers argue that stand-alone open-air parking structures are different than normal parking garages, and that these structures do not meet the definition of a building because they fail the appearance test. As mentioned above, taxpayers argue that the stand-alone open-air parking structures fail the appearance test because they: 1) do not contain walls or a roof for the specific purpose of sheltering people or vehicles; 2) are open to the elements (weather); and 3) do not have many of the structural components of a building or do not share structural supporting elements with a building.

1. Walls or Roof

To support their no roof theory, taxpayers claim that each new level in the parking structure does not constitute a roof for the level below. However, the levels constitute something like a ceiling, much the same way each floor in any other building serves as a ceiling for the level below. Lighting, signage and, if required, fire systems are attached to the bottom side of each new level. The only level that does not have a ceiling is the rarely-used top level. The top level is simply a useable roof, much like a rooftop deck on an apartment building.

Even stand-alone open-air parking structures normally have walls, although the exterior walls do not extend to the ceiling except when required for support. The walls are necessary to prevent cars from driving off the side. A number of cases have held that walls are not necessary. See Consolidated Freightways, Inc. v. Commissioner, 708 F.2d 1385 (9th Cir. 1983), affg. in relevant part 74 T.C. 768 (1980) (loading docks without permanent walls were buildings under the appearance test; this result applies even if there were no overhead doors.); Yellow Freight System, Inc. v. Commissioner, 538 F.2d 790, 795-796 (8th Cir. 1976) (similarly; lack of clearly discernible walls was not controlling); Rev. Rul. 79-406, 1979-2 C.B. 18 (car wash is a building, despite lack of exterior walls on two sides of the structure).

2. Open to Elements

Even stand-alone open-air parking structures are not entirely open to the elements — they have a roof and partial walls. These walls may not extend to the ceiling but are high enough to shield vehicles from most precipitation and some wind. The properties in Consolidated Freightways and Yellow Freight System were classified as buildings despite the lack of permanent walls. These parking structures are large enough so that only those vehicles closest to the edges may get wet if it rains. It is true that these parking structures usually lack heat and air conditioning, but the lack of temperature control cannot be sufficient to establish that a structure is not a building.

3. Structural Components or Structural Supporting Components

The taxpayers sometimes argue that stand-alone open-air parking structures do not have many of the structural components of a building provided under Treas. Reg. § 1.48-1(e)(2) and, therefore, are not a building. Parking structures have walls, floors, elevators, stairs, sprinkler systems, fire escapes, and electric wiring and lighting fixtures. While these parking structures lack some of the structural components listed in Treas. Reg. § 1.48-1(e)(2), the regulation does not require that all listed structural components are needed in a structure to classify it as a building.

The taxpayers also sometimes state that stand-alone open-air parking structures do not share structural supporting elements with a building. They apparently make this statement because they are aware that property may be other property and not a building but still be treated as a structural component of a building. Illinois Cereal Mills, Inc. v. Commissioner, 789 F.2d 1234, 1239 (7th Cir. 1986). Taxpayers, however, typically agree that if an open-air parking structure shares a wall or other structural supporting elements with another building, then it should be classified as a building. Moreover, the position of the Service is that the parking structures are themselves buildings such that the Service does not generally argue that the parking structures are structural components of buildings.

Taxpayers have not cited any support for their position that a structure, which functions as a building, is not a building.

Finally, properly maintained and built open-air parking structures can be expected to perform well for 25 to more than 40 years.

An accuracy-related penalty for a substantial understatement of income tax should be considered if the understatement is substantial; and as an alternative, in the light of the lack of support for the taxpayer position, an accuracy-related penalty for negligence or disregard of rules or regulations should be strongly considered.

Substantial Understatement

§ 6662(b)(2) imposes a twenty percent accuracy-related penalty that applies to any substantial understatement of income tax. § 6662(d) defines substantial understatement differently for corporations (other than S corporations and personal holding companies) from the definition for non-corporate taxpayers. For corporations, there is a substantial understatement for a taxable year if the understatement exceeds the lesser of (1) 10 percent of the tax required to be shown on the return for the taxable year (or, if greater, $10,000), or (ii) $10,000,000. § 6662(d)(1)(B). For S corporations, personal holding companies, and all non-corporate taxpayers, there is a substantial understatement if the amount of the understatement exceeds the greater of (i) 10 percent of the tax required to be shown on the return for the taxable year, or (ii) $5,000. See § 6662(d)(1)(A).

For purposes of § 6662(d)(1), the term understatement means the excess of (i) the amount of tax required to be shown on the return, over (ii) the amount of tax imposed which is shown on the return, reduced by any rebate (within the meaning of § 6211(b)(2)). § 6662(d)(2). To the extent that a taxpayer has substantial authority for the reported tax treatment or adequately discloses that treatment in the return or on a statement attached to the return and there is a reasonable basis for the tax treatment of the item, the amount of the understatement is reduced. See § 6662(d)(2)(B).

Where a substantial understatement exists, its proof is a matter of establishing that the amount of tax required to be shown on the return exceeds the amount of tax shown on the return (reduced by any rebates), and whether the difference surpasses the relevant threshold provided in § 6662(d)(1)(A) or (B). This proof is simpler than making the case for the accuracy-related penalty for negligence or disregard, discussed below, and should be pursued where the facts support its assertion.

Negligence

§ 6662(b)(1) imposes a twenty percent accuracy-related penalty that applies to the portion of any underpayment of tax attributable to negligence or disregard of rules or regulations.

Negligence under § 6662 includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code or to exercise ordinary and reasonable care in the preparation of a tax return. See § 6662(c) and Treas. Reg. § 1.6662-3(b)(1). Negligence also includes the failure to do what a reasonable and ordinarily prudent person would do under the same circumstances. See Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967), aff'g 43 T.C. 168 (1964); Neely v. Commissioner, 85 T.C. 934, 947 (1985). Treas. Reg. § 1.6662-3(b)(1)(ii) provides that negligence is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return that would seem to a reasonable and prudent person to be “too good to be true” under the circumstances. A return position that has a reasonable basis as defined in Treas. Reg. § 1.6662-3(b)(3) is not attributable to negligence. See Treas. Reg. § 1.6662-3(b)(1). A reasonable basis is a greater standard than merely arguable or merely a colorable claim. See Treas. Reg. § 1.6662-3(b)(3).

Disregard of rules or regulations “includes any careless, reckless or intentional disregard.” See § 6662(c) and Treas. Reg. § 1.6662-3(b)(2). The term rules or regulations include provisions of the Internal Revenue Code, temporary and final regulations, and revenue rulings and notices (other than notices of proposed rulemaking). See Treas. Reg. § 1.6662-3(b)(2). A disregard is careless if the taxpayer fails to exercise reasonable diligence to determine the correctness of a return position that is contrary to a rule of regulation, reckless when a taxpayer makes little or no effort to determine whether a rule or regulation exists, and intentional if the taxpayer knows of the disregarded rule or regulation. Id. Outside the reportable transaction context, a taxpayer has not disregarded a rule or regulation when taking a position contrary to a ruling or notice if the taxpayer’s position has a realistic possibility of being sustained on its merits. Id.

Burden of Production and Proof

The taxpayer has the ultimate burden of proof in overcoming the presumption that the Service's determination of an accuracy-related penalty is correct. Marcello, 380 F.2d at 507. With respect to examinations commencing after July 22, 1998, however, the Service must first meet the burden of production with respect to the imposition of additions to tax and penalties; and to meet that burden, the Service must produce evidence sufficient to show that imposing the penalty is appropriate, but the Service need not introduce evidence regarding reasonable cause, reasonable basis, substantial authority, or similar provisions. See § 7491(c) and Higbee v. Commissioner, 116 T.C. 438, 446 (2002).

Analysis

The Service is unaware of any authority that suggests a stand-alone open-air parking structure is not a building. While taxpayers attack the IRS' position, they offer no affirmative justification for their position nor do they explain why a parking structure, which is an inherently permanent structure, is not a building. In fact, a parking structure is so commonly regarded as a building that to argue otherwise is frivolous.

Taxpayers attempt to distinguish the parking structures at issue to avoid classification as a building. To distinguish the parking structures, taxpayers may argue that stand-alone open-air parking structures lack the physical features of a building. For example, taxpayers may suggest that the walls of a parking structure do not provide enclosure. On the contrary, the walls separate the parking structure from the surrounding area, enclosing vehicles within the structure. Taxpayers may also argue that the components of a stand-alone open-air parking structure are not unique to buildings or that parking structures do not contain all Treas. Reg. § 1.48-1(e)(2) structural components. Arguing that components are not exclusive to buildings does not prevent a parking structure from being a building nor justify taxpayers' position that stand-alone open-air parking structures are not buildings. Additionally, all structural components listed in the regulation are not required to classify a structure as a building.

Taxpayers may further argue that a stand-alone open-air parking structure fails the function test because it does not provide workspace or shelter. However, Treas. Reg. § 1.48-1(e)(1) does not require that a building qualify under all possible building functions and specifically designates parking as a building function. Taxpayers may further argue that the floors of a parking garage provide a similar sheltering function as a canopy over a parking lot. Having a similar function as a canopy does not mean a parking structure is not a building because a canopy is not a building. The classification of one does not affect the classification of the other. For example, the purpose of a sundial and the purpose of a digital clock are both to tell time. However, the fact that a sundial is not an electric device does not mean a digital wristwatch is not an electric device.

Taxpayers can present no arguments that reasonably justify treating the stand-alone open-air parking structures as anything other than a building. Adopting an argument so lacking in legal foundation is negligent under § 6662, and ignoring the dictates of Treas. Reg. 1.48-1(e)(1) demonstrates disregard of that regulation.

§ 6664 Reasonable Cause Exception

§ 6664(c) provides an exception to the imposition of any § 6662 penalty if the taxpayer shows that there was reasonable cause and the taxpayer acted in good faith. See also Treas. Reg. 1.6664-4(a). The determination of whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all relevant facts and circumstances. See Treas. Reg. § 1.6664-4(b)(1). All relevant facts and circumstances, including the nature of the tax investment, the complexity of the tax issues, the independence of a tax advisor, the competence of a tax advisor, the sophistication of the taxpayer, and the quality of an opinion, must be developed to evaluate an assertion that a taxpayer acted with reasonable cause and in good faith. See IRM 20.1.5.6.1(7).

Generally, the most important factor in determining whether the taxpayer has reasonable cause and acted in good faith is the extent of the taxpayer's effort to assess the proper tax liability. For example, an isolated computational or transcription error generally is not inconsistent with reasonable cause and good faith See Treas. Reg. § 1.6664-4(b)(1) for guidance and additional examples, and also consider Larson v. Commissioner, T.C. Memo. 2002-295.

Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of the facts, including the experience, knowledge, sophistication and education of the taxpayer. See Treas. Reg. § 1.6664-4(b)(1). The taxpayer's mental and physical condition, as well as sophistication with respect to the tax laws, at the time the return was filed, are all relevant in deciding whether the taxpayer acted with reasonable cause. See Kees v. Commissioner, T.C. Memo. 1999-41. If the taxpayer is misguided, unsophisticated in tax law, and acts in good faith, a penalty is not warranted. See Collins v. Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988); cf. Spears v. Commissioner, T.C. Memo. 1996-341, aff'd, 98-1 USTC 50,108 (2d Cir. 1997) (Court was un-convinced by the claim of highly sophisticated, able, and successful investors that they acted reasonably in failing to inquire about their investment and simply relying on offering circulars and accountant, despite warnings in offering materials and explanations by accountant about limitations of accountant's investigation, stating “In each case, these taxpayers knew or should have known better.”).

Reliance upon a tax opinion provided by a professional tax advisor may serve as a basis for the reasonable cause and good faith exception to the accuracy-related penalty. See Treas. Reg. § 1.6664-4(c)(1). The reliance, however, must be objectively reasonable. Id. For example, the taxpayer must supply the professional with all the necessary information to assess the tax matter, and the advice must be based upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances. See Treas. Reg. § 1.6664-4(c)(1)(i).

In Long Term Capital Holdings v. United States, 330 F. Supp.2d 122, 205-11 (D. Conn. 2004), the court concluded that a legal opinion did not provide a taxpayer with reasonable cause where (1) the taxpayer did not receive the written opinion prior to filing its tax return, and the record did not establish the taxpayer's receipt of an earlier oral opinion upon which it would have been reasonable to rely; (2) the opinion was based upon unreasonable assumptions; (3) the opinion did not adequately analyze the applicable law; and (4) the taxpayer's partners did not adequately review the opinion to determine whether it could be reasonably relied upon. In addition, the court concluded that the taxpayer's lack of good faith was evidenced by its decision to attempt to conceal the losses reported from the transaction by netting them against gains on its return. Id. at 211-12.

The fact that a taxpayer consulted an independent tax advisor is not, standing alone, conclusive evidence of reasonable cause and good faith if additional facts suggest that the advice is not dependable. See Spears, T.C. Memo. 1996-341. For example, a taxpayer may not rely on an independent tax adviser if the taxpayer knew or should have known that the tax adviser lacked sufficient expertise, the taxpayer did not provide the adviser with all necessary information, or the information the adviser was provided was not accurate. See Spears, T.C. Memo. 1996-341; Pessin v. Commissioner, 59 T.C. 473, 488-489 (1972). Additionally, the analysis provided to the taxpayer must be reasonable in light of the experience, knowledge and education of the taxpayer. See Treas. Reg. § 1.6664-4(b)(1).

Finally, a taxpayer may not establish reasonable cause and good faith by relying on an opinion or advice that a regulation is invalid unless the taxpayer adequately disclosed the position that the regulation was invalid in accord with Treas. Reg. § 1.6662-3(c)(2). See Treas. Reg. § 1.6664-4(c)(1)(iii).

The reasonable cause and good faith exception to the accuracy-related penalties requires analysis of all the facts and circumstances, but in the light of the lack of support for the taxpayer position that the open-air parking structures are land improvements depreciable over 15 years and a regulation stating that these structures are buildings and thus depreciable over 39 years, the potential for the reasonable cause and good faith defense should not dissuade the Service from asserting the accuracy-related penalty.

The IRS and the taxpayer agree that stand-alone open-air parking structures are inherently permanent. The issue in dispute is whether these parking structures are buildings or land improvements for depreciation purposes. The taxpayer asserts that the parking structures are land improvements with a 15-year recovery period (under GDS) while the IRS asserts that the parking structures are buildings with a 39-year recovery period (under GDS).

Treas. Reg. § 1.48-1(e) is clear and unambiguous in providing that the term “building” includes structures such as garages, and structures the purpose of which is to provide parking space. Since garages and parking structures are explicitly included in the definition of a building under Treas. Reg. § 1.48-1(e), this should really be the end of the inquiry as to whether a parking structure is considered a building.

Taxpayers argue that the regulation is ambiguous and that a stand-alone, open-air parking structure does not satisfy the two-part definition of a “building”, namely the appearance test and the function test. Taxpayers, however, have not cited any support for their position that a structure, which appears and functions as a building is not a building. The Service is unaware of any authority that suggests a stand-alone open-air parking structure is not a building.

Taxpayers can present no arguments that reasonably justify treating a stand-alone open-air parking structure as anything other than a building. While taxpayers attack the IRS' position, they offer no affirmative justification for their position. Given the lack of support for the taxpayer position, an accuracy-related penalty under § 6662 for a substantial understatement (if applicable) and in the alternative for negligence or disregard of rules or regulations should be strongly considered.